8 1-Capital Adequacy

8/13/2019 8 1-Capital Adequacy

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Capital Adequacy

Compliance


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Objectives of Capital Adequacy Requirement

Fundamental objective for holding adequate capital by

banks

Strengthen the soundness of banks

Stability of the banking system

Provide a stable resource to absorb losses

Loss absorption capacity based on the business risk


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Capital Fund

Division of capital fund

Characteristics of instruments

Quality of instruments

Supervisory requirements


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Elements of Tier I Capital

Paid-up capital (ordinary shares)

Statutory reserves

Other disclosed free reserves

Perpetual non-cumulative preference shares (PNCPS)

eligible for inclusion as Tier I capital

Subject to laws in force from time to time

Innovative perpetual debt instruments (IPDI) eligible forinclusion as Tier I capital

Capital reserves representing surplus arising out of sale

proceeds of assets


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Elements of Tier II Capital

Undisclosed reserves

Revaluation reserves

General provisions

Loss reserves

Hybrid capital instruments

Subordinated debt

Investment reserve account


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Undisclosed Reserves

Represent accumulations of post-tax profits

Not encumbered by any known liability

Not routinely used for absorbing normal loss

Not routinely used for absorbing operating losses


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Revaluation Reserve

Revaluation reserves at a discount of 55 per cent for Tier

II capital.

Disclosed in the balance sheet as revaluation reserves.


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General Provisions and Loss Reserves

Identifiable potential loss in any specific asset.

Available to meet unexpected losses.

Sufficient provisions have been made to meet all known

losses and foreseeable potential losses before

considering general provisions and loss reserves to be

part of Tier II capital.

General provisions and loss reserves considered up to a

maximum of 1.25 percent of total risk weighted assets.


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Floating Reserves

General in nature

Not made against any identified assets

Excess provisions which arise on sale of non performing

assets eligible for Tier II capital

Applicable ceiling 1.25% of total risk weighted assets


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Hybrid Debt Capital Instruments

Instruments that have close similarities to equity

instruments

Instruments that support losses on an ongoing basis

without triggering liquidation

Debt capital instruments eligible for inclusion as upperTier II capital

Perpetual Cumulative Preference Shares (PCPS)

Redeemable Non Cumulative Preference Shares

(RNCPS)

Redeemable Cumulative Preference Shares (RCPS)


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Subordinated Debt

Approval of the Board

Rupee-subordinated debt as Tier II capital Maturity period initially less than 5 years

Subject to progressive discount

Maturity of the Instrument Rate of discount

Less then one year 100%

1 year > 2 years 80%

2 years > 3 years 60%3 years > 4 years 40%

4 years > 5 years 20%


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Subordinated Debt

Fully paid up instruments

Unsecured instruments

Subordinated to the claims of other creditors

Free of restrictive clauses

Not redeemable at the initiative of the holder

Not redeemed without the consent of Reserve Bank of

India


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Investment Reserve Account

Provisions created on account of depreciation in

Available for Sale

Held for Trading

Excess profits recognized in the income statement

Equivalent amount net of taxes and net of transfer to

statutory reserves appropriated to an investment reserve

account

Revenue and other reserves disclosed in the balance

sheet Investment reserve account (Tier II capital within the

overall ceiling of 1.25 per cent of total risk weighted

assets)


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Capital Funds of Foreign Banks

Tier II capital

Elements of Tier II capital as applicable to Indian

banks.

Head Office (HO) borrowings raised in foreign

currency (for inclusion in Upper Tier II Capital).


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Foreign Bank Capital Requirements

Foreign banks are required to furnish to Reserve Bank

undertaking to the effect that the banks will not remit

abroad the remittable surplus

retained in India and included in Tier I capital as long

as the banks function in India.

Retained in a separate account

In India for meeting capital to risk-weighted asset ratio(CRAR) requirements under capital funds.


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Auditor's certificate to the effect that these funds

represent surplus payable to

Head office once tax assessments are completed or tax appeals

are decided

Do not include funds in the nature of provisions towards tax or

for any other contingency


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Foreign banks operating in India are permitted to hedge

their entire Tier I capital held by them in Indian books

subject to:

Forward contract should be for a tenor of one year or

more and may be rolled over on maturity

Rebooking of cancelled hedge will require prior

approval of Reserve Bank

Capital funds should be available in India to meet

local regulatory CRAR requirements

Foreign currency funds accruing out of hedging

should not be parked in nostro accounts but should

remain swapped with banks in India at all times


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Capital reserve representing surplus arising out of sale

of assets in India held in a separate account is noteligible for repatriation so long as the bank functions in

India

Interest-free funds remitted from abroad for the purpose

of acquisition of property should be held in a separate

account in Indian books

Net credit balance in the inter-office account with head

office / overseas branches will not be considered as

capital funds.

Debit balance in head office account will have to be set-

off against the capital


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Deductions for Tier I and Tier II Capital

Equity and non equity investments in subsidiaries

Investments of a bank in the equity as well as non-equity

capital instruments issued by a subsidiary, which are

considered towards its regulatory capital as per norms

prescribed by the respective regulator, deducted at 50

per cent each, from Tier I and Tier II capital of the parent

bank, while assessing the capital adequacy of the bank

under the Basel I framework


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Credit Enhancement Relating to Securitization of

Standard Assets

Treatment of First Loss Facility

First loss credit enhancement provided by the

originator reduced from capital funds and the

deduction capped at the amount of capital that the

bank would have been required to hold for the full

value of the assets, had they not been securitised.

Deduction for this purpose would be made at 50%

from Tier I and 50% from Tier II capital


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Standard Assets

Treatment of Second Loss Facility

Second loss credit enhancement provided by the originator

would be reduced from capital funds to the full extent.

Deduction would be made at 50% from Tier I and 50% from Tier

II capital

Treatment of credit enhancements provided by third party

If the bank is acting as a third party service provider, the first loss

credit enhancement provided by it is reduced from capital to the

full extent


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Standard Assets

Underwriting by an originator

Securities issued by the Special Purpose Vehicles (SPVs) and

held by the bank in excess of 10 per cent of the original amount

of issue, including secondary market purchases, deducted at

50% from Tier I capital and 50% from Tier II capital

Underwriting by third party service providers

If the bank has underwritten securities issued by SPVs which are

below investment grade, then deducted from capital at 50% from

Tier I and 50% from Tier II capital


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Illustrative Application of Tier I Capital

Tier I capital

Paid up capital

Statutory reserves

Disclosed free reserves

Capital reserves representing surplus from sale

proceeds of assets

Minus equity investment in subsidiaries

Minus intangible assets

Minus losses incurred by the bank


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Illustrative Application of Tier II Capital

Un-disclosed reserves and cumulative perpetual

preference shares Revaluation reserves (at a discount of 55 percent while

determining their value for inclusion in Tier II capital)

General provisions and loss reserves up to a maximum

of 1.25% of weighted risk assets

Investment fluctuation reserve not subject to 1.25%

restriction

Hybrid debt capital instruments (bonds)

Subordinated debt (long term unsecured loans)


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Application of Risk Weighted Assets

Non-funded (off-balance sheet) Items

Credit risk exposure of off-balance sheet items

Computed by multiplying the face value amount of

each of the off-balance sheet items by the credit

conversion factor

Resulting amount has to be again multiplied by the

relevant weights assigned for each off-balance sheet

item


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Reporting Requirements

Disclose in balance sheet the quantum of

Tier I capital fund

Tier II capital fund

Annual return indicating capital funds

Conversion of off-balance sheet items

Non-funded exposures

Computation of risk weighted assets

Computation of capital to risk assets ratio


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Capital Adequacy Ratio

Capital Adequacy Ratio / (CAR) / (CRAR)

Ratio of capital fund to risk weighted assets expressed in

percentage terms

Minimum Requirements of Capital Fund in India

Existing banks: 9 %

New private sector banks: 10 % Banks undertaking insurance business: 10 %

Local area banks: 15 %

Tier I capital at no point of time be less than 50 % of the

total capital.

Tier II capital cannot be more than 50 % of the total

capital

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8 1-Capital Adequacy

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